Having finished my reading on CBOE's method of calculating the VIX on out of the money call and put options written on S&P 500,I have a thought about the ability of market making firms to manipulate the market. The calculation of VIX uses option prices with positive bid price, and each option contributes to the implied volatility as a whole. So, is it possible for a market-making firm to go long in VIX futures and immediately provide a bid price for out-of-the money options?
Definitely - but I would look to see how much that 1 additional bid price of
0.05 or more would impact the price of the index. Or, try doing it with 10-15 more bids (or however many). The index is weighted to at-the-money options much more, noting "Contribution by Strike":
I'm also a little uncertain how live bids are manipulating a market. If you think the bid is unwarranted, sell it! (Perhaps this is a little contentious - it reminds me of the DRW bid scandal. I was unsure of my opinion then, too.)